If you've recently begun to plan the distribution of your assets after death through your last will and testament, you may be concerned about precisely what will be left to your heirs. After spending decades guiding your children or other younger family members through their early lives, the last thing you want to do is leave them with financial obligations or a hefty tax bill as your last "gift." Read on to learn more about the steps you can take to streamline your estate and ensure that your heirs -- not the government -- most directly benefit from your years of hard work.
Will your heirs be required to pay inheritance taxes on your estate?
Because Canada does not have an estate tax (often commonly referred to as a "death tax"), your heirs will not be required to give up any portion of the funds they've already received to pay taxes owed. The matter of taxes owed should be settled by the executor prior to the closing and distribution of the estate.
However, if you die without leaving a surviving spouse, the transfer of your estate to heirs will legally be considered a sale of all underlying assets. This means that if certain assets were acquired at a low cost (such as stocks purchased decades ago, or your old family home purchased for a song), your estate will be required to pay capital gains taxes of your regular marginal tax rate on 50 percent of the amount of gain realized. To put it in simpler terms, if you purchased your house for $10,000 and "sold" it for $110,000 when transferring it to your estate, your estate would be responsible for paying your marginal tax rate on $50,000 in gains.
The executor of your estate will be required to make an accounting of all existing assets and debts, as well as the value of these assets for estate tax purposes. Once the total amount of tax owed has been determined, the executor will skim this amount off the top of your estate and receive a certification from the Canada Revenue Agency (CRA) that all owed taxes have been paid. The executor will then distribute the remaining assets according to your will or the intestate law in your province. If the executor performs this distribution before receiving the "all clear" from CRA, he or she may then be personally responsible for paying any additional taxes owed.
How can you avoid paying high tax rates after death?
Although you can't take your money with you, you may want to preserve most of it for your heirs, rather than give it up to taxes. There are a few things you can do before death to minimize the tax consequences of transferring your assets to your estate.
- Look into the creation of a trust
A trust can help shield assets from the CRA after you die. When you die without a trust, any assets in your name will be immediately transferred to your estate -- incurring tax liabilities along the way. However, trust assets pass to the beneficiary outside your estate, helping avoid taxes on this transfer. Although you'll be required to pay taxes on certain assets once they're titled in someone else's name, if these assets continue to appreciate in value while inside the trust, this resulting gain may pass to heirs tax-free.
- Give away your home -- but keep a life estate
If, like many Canadians, your most valuable asset is your home, you may be able to avoid taxes on this transfer by preemptively transferring your home during your lifetime. However, you'll still need somewhere to live! By retaining a life estate in your home, you'll ensure that you always have a comfortable domicile while avoiding the forced sale or taxation of your home. Upon your death, the life estate will extinguish and the home will be fully owned by the heirs to whom you transferred it.
For more information and tips, contact a local estate lawyer.